Purpose of Life Insurance

People or entities purchase life insurance for various reasons, and the reasons can change over time. A newly married couple, for example, may purchase insurance for income replacement; high-earning professionals may purchase it to build supplemental retirement income because they have maxed out contributions to their 401(k) and other qualified plans; parents may purchase it to fund education or to provide incentive or reward “pensions” for their children; grandparents may purchase it to provide legacy gifts to their children, grandchildren, or charities; high-net-worth individuals may purchase it for tax-advantaged cash accumulation; risk-taking entrepreneurs may purchase it for asset protection purposes.

Under a life insurance contract, a person or entity (the policy owner and/or applicant) purchases insurance coverage on the life of a person (the insured) for a stipulated amount of money (premium). Upon the death of the insured, the insurance company pays a death benefit to named beneficiaries in the amount of coverage purchased. Life insurance contracts may be terminated (surrendered) by the policy owner at any time, for any or no reason. If the policy owner does so, the insurance company will remit to the policy owner the cash value of the policy, which is the amount of equity in a policy that results from premiums in the early policy years that exceed what is necessary to cover the mortality cost and expense of the contract. Some types of insurance do not have cash value, term insurance for example.

Often, insureds own their policies personally. Individuals or couples with estates large enough to have estate tax liability ($5,430,000/individual in 2015) can face unwanted consequences if they do so; when the insured dies, the death benefit paid increases the value of the estate, and so also increases the estate’s tax liability. Because, however, an insurance policy need not be owned personally, insureds can use a variety of estate planning strategies to eliminate or reduce that tax liability.

Purpose of Trust Owned Life Insurance

One way to protect an insurance policy from estate tax liability and to provide liquidity is to create a Grantor trust. A trust is a legal relationship in which one party holds property for the benefit of another party; a Grantor trust is a legal entity created by an individual called a Grantor, and can be used for a variety of purposes. A Grantor trust may be either revocable by the Grantor or irrevocable. A type of Grantor trust often used in estate planning is an Irrevocable Life Insurance Trust (ILIT). With a well-drafted ILIT, trust income is imputed to the Grantor, but the trust assets are not included in the Grantor’s estate for estate tax purposes. In other words, the Grantor pays the income tax on trust income, but trust assets will not be subject to estate tax at the death of the Grantor.  With an ILIT, the effect of the Grantor paying the income tax is to further leverage the transfer to the Trust beneficiaries without incurring additional gift tax cost.

Assets, and the income earned on assets, owned by ILIT are no longer owned by the insured and will not be part of the insured’s estate. At the death of the insured, because the assets are owned by the trust, they will not be subject to federal estate tax or probate. In order for an insurance policy owned by an ILIT to be outside of the insured’s estate, the insured must give up all the “incidents of ownership” in the policy. Incidents of ownership include any rights to use, control, or modify the policy (i.e., the right to change the beneficiary, transfer ownership, use the policy value as collateral, etc.). The trustee, rather than the insured, applies for and purchases the policy from the insurer. At the time of the insured’s death, the trustee uses the proceeds from the death benefit to purchase assets from or make loans to the estate, thereby providing liquidity for administrative expenses and payment of federal estate tax.

Types of Life Insurance

Insurance carriers continually innovate new policy structures to create products that differentiate themselves from other carriers. In general, though, there are two primary types of life insurance, term insurance and permanent insurance. These trusts also are referred to as “Income Defective” Grantor trusts. However, in this case, the “defect” is entirely intentional.

Term insurance

Term insurance is a temporary solution whose price structure makes it economically infeasible to own and fund if the insured lives near to life expectancy or beyond. Purchasing term insurance can be an appropriate solution when any of the following circumstances apply: (1) the need for protection is temporary; (2) there is a need for a large amount of coverage and limited funds are available to pay for the coverage; and (3) when younger clients have need for death benefit protection but cannot afford the higher premiums of permanent insurance. Fewer than 2% of term life insurance policies ever pay a death benefit. The insured usually outlives the term of the contract or, to assure that a death benefit is paid, purchases the term contract specifically to convert it to a permanent policy that can be owned at and beyond life expectancy. Term premiums are pure expense as opposed to instruments with the potential for positive return.

Permanent insurance

In contrast, permanent insurance provides coverage for the insured’s entire life, provided that adequate premiums are paid. Within permanent insurance, cash value accumulates on a tax-deferred basis. If the permanent product is a cash accumulation type product, the death benefit is income tax free. If the policy is surrendered, the cash value is paid to the policy owner and gain in excess of premiums paid can be taxable as ordinary income. The owner of a permanent insurance policy may access cash value while keeping the policy in force, in any of the following ways:

  •  Taking a policy loan at competitive or zero interest rates;
  • Receiving accumulated cash value by surrendering paid-up additions of death benefit;
  • Receiving income-tax free surrenders/withdrawals up to the policy owner’s cost basis in the policy;
  • Using cash values to reduce the premium when values are sufficient to do so.

There are two general categories of permanent insurance: universal life (UL) insurance and whole life (WL) insurance.

Universal Life permanent insurance

Universal life insurance is a flexible premium type of permanent insurance which combines death benefit protection and cash accumulation potential through guaranteed and current crediting rates and a wide variety of flexible features and options. In general, there are four types of universal life insurance: Cash Accumulation Universal Life (CAUL) insurance, Guaranteed Universal Life (GUL) insurance, Indexed Universal Life (IUL) insurance, and Variable Universal

Life (VUL) insurance:

Cash Accumulation Universal Life (CAUL) insurance products provide level or adjustable premiums and coverage, with the potential for income- tax– free cash-value accumulation within the policy. Cash values in a CAUL policy may increase via a crediting rate based on the performance of certain assets held in the company’s general account. The crediting rate generally reflects a bond- like return and is based on the general account of the insurance carrier.

Guaranteed Universal Life (GUL) insurance products offer a guaranteed death benefit and guaranteed premium through a secondary guarantee, provided that premiums are paid as specified on the compliance ledger by the due date, and that loans and withdrawals are not taken. Regardless of fluctuations in the interest crediting rate, the carrier may not increase premiums during the life of a GUL contract. These contracts are generally inflexible, offering little or no cash accumulation. For this reason, this type of contract is often referred to as “permanent term.”

Indexed Universal Life (IUL) insurance products offer the flexibility of CAUL products in terms of premiums and death benefit options. IUL products additionally allow participation in market upside with the guarantee of no losses due to market declines. (This guarantee can take the form of a 0% floor on the indexed account strategies offset by a cap and/or a participation rate on the upside, which can vary at the discretion of the insurance company.) The owner of an IUL policy can choose a crediting rate strategy from among a fixed account and a choice of indexed accounts, such as the S&P 500. The index crediting rate generally is calculated as a point-to-point percentage gain over a fixed period with variations based on the carrier and contract (usually 1, 2, or 5 years).

Variable Universal Life (VUL) insurance products offer similar features to CAUL products, with the added flexibility to allocate a portion of each premium to one or more investment options called sub-accounts. Sub- accounts are similar to institutionally priced mutual funds comprised of stocks, funds, and/or bonds. As with CAUL products, the death benefit and premium structure may be modified to meet changing needs. Variable universal life insurance has upside potential and downside risk due to market performance, with no guaranteed floor.

Private Placement Variable Universal Life (PPVUL) are non- registered contracts that are offered exclusively to high net worth individuals. PPVUL is a non-registered U.S. tax compliant flexible premium life insurance policy that provides the same income tax-exempt death benefits as other variable life insurance policies. Premiums, less charges and fees, are invested into various investment options inside the insurer’s separate account. PPVUL provides flexible investment options (with some non- registered investments within asset classes that are not available in other life insurance policies) and flexible premium payments. Hedge funds complement a traditional portfolio of stocks and bonds. Since hedge fund returns are often independent of the overall direction of the stock and bond market these funds can provide diversification to the total portfolio, and hence provide a better risk-return profile than just stocks and bonds alone.

Whole Life permanent insurance

Finally, Whole Life (WL) insurance products provide permanent life insurance protection with guaranteed premiums, cash values, and death benefits. The base policy death benefit is guaranteed to be paid at the insured’s death, provided that the contract premium is paid when due. The premium cost of Whole Life contracts, generally, is higher than other types of permanent insurance. The policies are not as transparent as universal life policies, making it difficult to manage access to cash value. Whole Life contracts that are classified as participating offer the possibility of policy dividends. Such policy dividends are not guaranteed, and represent a return to the policy owner of part of the premium paid.


Each insurance contract has objectives that the policy is intended to serve, planned or required premiums and a premium funding schedule, projected cash values, a projected death benefit, and projected policy maturity. It’s important to review the policy regularly (at least annually) to assure that the policy owner’s objectives continue to be met, to assess how the policy is performing in relationship to the initial benchmarks, and to evaluate if any changes in the policy owner’s financial or personal situation affect the original objectives and thus require modification of the policy’s ownership, beneficiary, funding strategy, etc. If the contract has a guaranteed death benefit and guaranteed premiums, with premiums required annually, validating that premiums were paid on time and credited to the policy accurately are critical to maintaining the guarantee. It also is prudent, with all policies, to review the carrier’s financial status to assure that the carrier will be able to meet its obligations to its policyholders. In a policy with crediting rates or rates of return that vary with the interest rate environment or equity markets, it is important to review the policy allocation or the carrier’s declared crediting rates. Crediting rates or market returns lower than initially projected might require additional premiums to maintain the policy to its desired maturity date; higher crediting rates or market returns may allow reduced premiums, fewer premium paying years, or the withdrawal or distribution of cash from the policy.

Insurance policies are a financial asset and, like all financial assets, must be reviewed and managed on a regular basis, not only for performance, but to assure that the legal and tax environment, the product, and the performance are aligned to meet the policy owner’s objectives as any or all of them change over time.


In conclusion, which type of insurance and how it is owned is determined by the what each person(s) is trying to achieve.  People utilize insurance for income replacement, estate planning, asset protection and a variety of other reasons.  Through a partnership, we’ve been able to significantly reduce the cost of insurance thereby increasing the cash values and death benefits in the case of permanent insurance.  If you’re interested in learning more, we’re happy to speak with you one-on-one.

Proper Wealth Management’s (“Proper”) blog is not an offering for any investment. It represents only the opinions of Jared Toren and Proper . Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement, or inducement to invest. Jared Toren is the CEO of Proper, a Texas based Registered Investment Advisor.   All material presented herein is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without prior notice. Information contained herein is believed to be accurate, but cannot be guaranteed. This material is based on information that is considered to be reliable, but Proper and its related entities make this information available on an “as is” basis and make no warranties, express or implied regarding the accuracy or completeness of the information contained herein, for any particular purpose. Proper will not be liable to you or anyone else for any loss or injury resulting directly or indirectly from the use of the information contained in this newsletter caused in whole or in part by its negligence in compiling, interpreting, reporting or delivering the content in this newsletter.  Opinions represented are not intended as an offer or solicitation with respect to the purchase or sale of any security or financial instrument, nor is it advice or a recommendation to enter into any transaction. The material contained herein is subject to change without notice. Statements in this material should not be considered investment advice. Employees and/or clients of Proper may have a position in the securities mentioned. This publication has been prepared without taking into account your objectives, financial situation or needs. Before acting on this information, you should consider its appropriateness having regard to your objectives, financial situation or needs. Proper Wealth Management is not responsible for any errors or omissions or for results obtained from the use of this information. Nothing contained in this material is intended to constitute legal, tax, securities, financial or investment advice, nor an opinion regarding the appropriateness of any investment. The general information contained in this material should not be acted upon without obtaining specific legal, tax or investment advice from a licensed professional.

Author: Jared Toren

Jared Toren is CEO and Founder at Proper Wealth Management. Proper was born out of frustration with the inherent conflicts of interest at big brokerage firms influencing advisors to sell products that were not suitable for clients but profitable to the firm along with a consistently mixed message of who’s interest was supposed to be put first; the clients’, the firms’, shareholders or advisors.

At Proper, our clients interests come first. We are compensated the same regardless of which investments we utilize so there’s no incentive for us to sell high commission products. Since we focus on a small number of clients, we are able to truly tailor our advice to each person’s unique circumstances.